Money Market Mutual Funds

The
final group of fund types in our search for the best mutual funds
is money market funds. As we saw earlier the principle difference between a
money market fund and a bond, is time. Money market funds are defined as
short term loans, with the maximum being 397 days or 13 months. The terms of
the loans are strictly controlled in order to manage risk, with strict rules
governing the use of the money by the borrower. Money market funds are often
described as the safest type of all mutual funds, and whilst it is almost
impossible to lose your original capital, your returns will probably suffer
from the effects of inflation as we shall see when we look at the risks and
rewards of mutual fund investing.

In broad terms there are really only two types of money market funds, namely
taxable and tax exempt, so a little more straightforward than the other
funds we have look at so far! Let's look at each group starting with the tax
exempt money market fund.

Best Mutual Fund - Tax Free Money Market Fund

Tax free or tax exempt money market funds are those that invest in loan
securities issued by the state or local government and on which the interest
earned is free from federal income tax. The first of these was issued in
1977, but really only became popular during the mid 1980's and early 1990's.
In recent years, there has been an enormous growth in locally issued
securities within a state, which offer the threefold benefit of being free
of federal, state, and in some cases local taxes as well ( though not always,
so you will need to read the small print carefully) - so truly tax free in
the broadest sense. These are often referred to as double-tax free, or
triple-tax -free. These types of money market mutual funds have proved particularly popular in
areas of both high taxes and high populations such as California and New
York.

All money market funds are tightly regulated by the
Securities and
Exchange Commission under the Investment Company Act of 1940. The SEC
regulates the length of time to maturity ( generally 13 months maximum ),
the maximum percentage of the fund which may be invested in one issuing body
( 5%) and various rules for rating of the loan debt according to credit
scores for the issuer. The key component for all money market funds is that
they must be highly liquid and therefore easily convertible back to cash.
This applies to both tax exempt and taxable money market mutual bonds. Under
SEC rules, the average maturity of all money market funds, whether tax free
or otherwise must be around 90 days in order to fulfil this criteria.

When comparing tax free returns against taxable money market returns the
initial result can be misleading, as on paper you will generally see that
a tax free mutual fund will often return less, however, you must remember
that you do keep more of the income due to the tax free rating, so we have
to look at something called comparative yield or taxable equivalent yield.
We'll look at this in more detail when explaining some of the terms and risk
and rewards associated with all the various types of mutual funds, and how
to pick the best ones. As a general rule, taxable money market funds are
generally better for regular investors, whilst tax free funds will tend to
be the best, the higher the rate of tax you pay.

Best Mutual Fund - Taxable Money Market Fund

Taxable money market funds work in much the same way as the above, except
that of course they are taxable. Typically they invest in Treasury bills and Commercial
paper, and you will have to pay federal tax on any income. These two
groupings are often listed separately as either General Funds which
invest in commercial or bank issued loans, and Government Funds which invest
in US Treasuries. In addition we also have GNMA (
Government National Mortgage Association ) and FNMA, (
Federal National
Mortgage Association ) loans, often abbreviated to Ginnie Mae and Freddie Mac. Both
of these are chartered by Congress( and therefore very safe ) and have been
established to buy mortgages from lenders, and then to repackage them to
sell on as securities. This provides a continuous flow of money to the banks
and lending institutions who are then able to issue further mortgages to
borrowers. This practice has been a contributory factor to the recent sub
prime mortgage crisis which has engulfed world economies over recent years,
and is still continuing today.

One of the interesting characteristics of money market funds is that with
most funds you do have the ability to write cheques against the funds,
generally around a minimum of $500. However please remember that there is
one significant difference between a regular checking account with a retail
bank, and the same facility with a money market fund - your deposits in a
bank are secure and guaranteed, whereas in a fund they are not, so please
always remember this fact when considering investing in money market mutual
funds.

Now, having looked at money market funds, let's take a look at some
of the odd terms you will come across when you research the market looking
for the best mutual funds.